Three reasons why Europe is the place to invest next year

LONDON (MarketWatch) — It’s time to invest in Europe, top investment banks say.

While the region’s stock markets massively disappointed in 2014, a lot is falling into place — lower oil prices, a weaker euro and possibly more easing from the ECB — that should make the continent one of best places to put money next year, their analysts note.

“Europe was a market ‘darling’ this time last year, then became a pariah,” economists at Morgan Stanley said in their year-ahead outlook. “[Now] we like European equities, (especially cyclicals) and European ABS.”

Mislav Matejka, chief European equity strategist at J.P. Morgan, goes as far as to predict eurozone equities will outperform U.S. stocks next year.

Not all investment banks keep targets for the benchmark Stoxx Europe 600 index
SXXP, -0.59%
But by pulling together data from their year-end outlooks, a picture emerges: The lackluster showing by the Stoxx 600 in 2014 could be turned into a 13% improvement in 2015.

To dig a bit deeper, the slides below look at the sectors tipped by banks, their targets and what the must-avoids in Europe are for investors in the coming 12 months.

The outlook: Stay overweight Europe in 2015

Year-end targets for the Stoxx Europe 600

Firm

Stoxx 600 target

Upside from current level*

Goldman Sachs

365

11%

J.P. Morgan

380

15%

Barclays

400

21%

Société Générale

350

6%

Average

373.75

13%

* Closing level as of Dec. 17

Here are the three factors that could help lift European equities next year, according to the banks’ analysts:

Loose monetary policy from the European Central Bank: ECB President Mario Draghi has already hinted the eurozone’s central bank is looking at introducing some sort of further stimulus in early 2015, possibly sovereign-bond purchases. The ECB intends to add about €1 trillion to its balance sheet over the next few years, and the extra liquidity pumped into the financial system is expected to beef up equity prices.

“The mantra is ‘Don’t fight the ECB’ — the central bank is set to inject €1,000 billion and to add sovereign bonds to its buying program,” analysts at Société Générale said in their year-ahead report published earlier in December.

A cheaper euro: The shared currency slumped almost 10% against the dollar in 2014, but the slide is not over yet, according to the wider analyst corps. The euro stands to lose 6% by the end of next year, pushed lower by the ECB’s aggressive stance on easing. A weaker currency usually benefits exporters, as their goods become cheaper for foreign buyers.

Morgan Stanley estimates that the currency tailwind will add at least 2% to earnings per share for European companies next year. Overall, Morgan Stanley estimates that European earnings will grow by 10% in 2015, but that estimate also reflects falling energy costs and lower borrowing costs.

Lower oil prices: These will still be making a splash in the new year. The price drops should translate into a smaller slice of consumer paychecks going to pay gas and energy bills — and that means more income to spend on something else. This should help spur growth not just in Europe, but across the global economy, analysts say.

Additionally, lower “input” costs — that is, expense of raw materials and energy — should benefit companies’ profit margins and help lift their earnings. But the commodity sector, and oil-related companies in particular, are likely to feel the squeeze from the oil-price plunge.

The sectors: Time to seek high-risk stocks

Goldman Sachs Global Investment Research

In 2014, defensive stocks such as utilities, which do well no matter the health of the wider economy, were the ones that did well. For 2015, it’s time to return to riskier plays, the investment banks say, with high hopes for these sectors in particular: financial, consumer discretionaries (nonessential goods and services) and airlines. But they still advise staying away from oil-related companies.

Here’s a look at what they say about each sector:

Banks are hot stuff: If the ECB goes all out with sovereign quantitative easing, expect the financial sector to be a key beneficiary. Additionally, the ECB’s Asset Quality Review — part of stress tests carried out last year —showed most major eurozone banks are in good shape, and should profit from an expected improvement in credit supply and loan demand.

Play the consumer: Falling energy and food prices mean consumers have more money to spend on stuff such as cars, traveling and clothes. Morgan Stanley’s top picks include Marks & Spencer
MKS, -1.75%
BMW
BMW, -0.41%
and hotel operator Accor
AC, -0.13%

However, consumer staples — companies selling goods like food and tobacco, seen as more “essential” — are not forecast to have a good year. That means steer clear of companies such as Danone
BN, -0.80%
Imperial Tobacco
UK:IMT
and Nestlé
NESN, -0.73%
analysts say.

The euro looks set to drop to $1.16 by the end of 2015, pushed down by the prospect of QE from the ECB and a strong dollar, going by the average of banks’ forecasts.

ECB easing: The central bank has vowed to expand its balance sheet to €3 trillion, but the banks’ analysts argue the market hasn’t priced that in yet.

“Europe will face a number of currency-negative events [next year]: negative euro headline inflation will force the ECB to deliver more easing, including sovereign QE,” currency strategists at Société Générale said.

A stronger dollar: While looser monetary policy is much expected for the eurozone, tighter policy seems to be in the cards in the U.S. Economists are still divided as to whether the Federal Reserve will hike rates in 2015, but the general feeling is that the dollar will still rise, in any case.

Goldman Sachs expects the euro to struggle to improve beyond 2015 and sees it trading on a par with the dollar in 2017. The shared currency is trading close to a two-year low against the greenback, and it has lost about 10% in 2014, according to data from FactSet.

The risks: Stay away from the U.K.

2015 year-end forecasts for U.K. stocks and the pound

Firm

FTSE 100 target

Change from current level*

GBP/USD target

Change from current level*

Barclays

7,300

15%

x

x

Goldman Sachs

7,100

12%

x

x

Morgan Stanley

7,200

14%

1.47

-6%

HSBC

7,000

10%

1.48

-5%

J.P. Morgan

7,200

14%

1.53

-2%

Société Générale

6,500

3%

1.50

-4%

UBS

x

x

1.60

3%

Investec

x

x

1.53

-2%

Nomura

x

x

1.49

-4%

Credit Suisse

x

x

1.53

-2%

Bank of America Merrill Lynch

x

x

1.58

1.3%

RBC Capital Markets

x

x

1.48

-5%

Average

7,050

11%

1.519

-3%

As of Dec. 17

The FTSE 100 index
UKX, -0.61%
has largely underperformed its European peers in 2014, and the analysts fear it could be more of the same next year. The investment banks’ outlooks advise shunning British equities, given the two factors below.

Political risks and “Brexit” fears: Most analysts agree that the upcoming general election in May is an element of uncertainty for the British market, and note there’s basically no silver lining in the result. Neither a left-wing nor right-wing government is seen as benefiting the market.

“When I look at the outcome, neither of them look particularly equity friendly,” said Graham Secker, Morgan Stanley’s head of pan-European equity strategy, at the bank’s year-ahead presentation.

“The market would traditionally prefer a right-wing government. But if the right-wing government is the government that’s planning to put an EU referendum on the table, and then you end up with two years of uncertainty. I’m not sure the markets would take that very positively either,” he said.

Polls suggest no single party will win a clear majority, so traders are already bracing for a difficult period of horse-trading. This could not only make a dent in U.K. stocks, but also the pound
GBPUSD, +0.2176%

Commodity hit: While weaker commodity prices are poised to boost the broader European market, it’s the exact opposite for the FTSE 100. Britain’s benchmark is heavily skewed toward the commodity sector through its listing of mining and oil firms. That means continued pressure on oil and metals could further give a knock to the market.

A roundup of the banks’ estimates still point to a sizable gain for the FTSE in 2015, but it’s worth noting that the forecasts were published before the market selloff in mid-December, where the benchmark shaved off 442.21 points in one week.

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information.
All quotes are in local exchange time. Real-time last sale data for U.S. stock quotes reflect trades reported through Nasdaq only.
Intraday data delayed at least 15 minutes or per exchange requirements.